MBS week sees above average volume and better buying

Mortgages have done well as the market has steadily strengthened with the 10-year Treasury yield trying to move below 4.50%. Despite the levels, last week saw above average volume with better buying overall. Real money, fast money and particularly servicers were very active with interest primarily focused in the 5.5% and 6.0% coupons.

Based on trader talk, about $5 billion traded in these coupons between Tuesday and Wednesday. The 5% coupons were also seeing support from some investors seeking duration. Asian buying also remained a modest participant in the overnight markets. In general, investors tended to move towards the sidelines with some profit-taking in the few times that the 10-year yield breached 4.50%. However, these buyers returned to take advantage of the cheapening when yields backed up above 4.50%. Originator selling was up last week, averaging about $1.5 billion per day. Supply has been primarily in 5.5% and 6.0% coupons.

In addition to the market levels, the approach of year-end has also stimulated bid list activity. This is expected to continue through December. In addition, interest has been shifting to specified pools for prepayment protection and better carry as the market continues to strengthen. Some month-end index buying was expected at Thursday's trading session. However, it was supposed to be limited as the Lehman Brothers' MBS Index was predicted to extend just 0.03-years on Dec.1. This compares to 0.13-years on the Treasury Index as a result of the refunding, 0.08-years for agencies, 0.10-years for credit, and 0.09-years for the aggregate.

Mortgages put in a strong performance in November with the MBS Index outperforming Treasurys by 30 basis points month-to-date through Nov. 29. Year-to-date, performance stands at 119 basis points. This compares to 126 basis points over Treasurys for CMBS, 104 basis points over for U.S. credit and 88 basis points over for ABS.

Next week's early week economic calendar is fairly light with just revised third quarter productivity and costs, factory orders, ISM Non-Manufacturing on Tuesday and Consumer Credit on Thursday. However, Friday gets the key non-farm payrolls report for November.

Any push towards 4.40% is not generally favorable for mortgages. Alec Crawford, head of agency MBS strategy at RBS Greenwich Capital, noted that 4.40% on the 10-year Treasury is the point of maximum negative convexity for the servicing market. He believes servicers will need to buy duration as well as volatility, noting that 4.35% is the point where FNMA 5.5s move above par. This will bring the majority of the mortgage market at over par - which is not good for mortgages. Also not favorable for mortgages would be the resulting higher volatility.

At the same time, mortgages have the benefit of paydown reinvestment coming on Thursday, followed by non-farm payrolls on Friday. Volatility typically declines following the release of the employment report.

In midweek research, UBS analysts remained favorable on mortgages, maintaining a modest overweight and looking for an opportunity to increase their overweight on weakness primarily because of strong seasonals. They recommended buying 15-year MBS versus Treasurys or swaps and to hold neutral on 15/30-year MBS trades. Bear Stearns analysts said volatility generally looks headed lower and swap spreads tighter and so nominal spreads should benefit. They noted continued good demand as well.

2007 conforming loan limit unchanged at $417,000

The Office of Federal Housing Enterprise Oversight announced last week that the 2007 conforming loan limits for single-family loans would remain unchanged at $417,000, as a result of a slight decline in average home prices over the October 2005 to October 2006 period. The Federal Housing Finance Board reported that the national average purchase price for a single family home was $306,258 last October, compared to $306,759 in October 2005. This is the first time since the 1992 to 1993 period that average home prices declined.

On Nov.15, the OFHEO issued a press release stating that if the October-to-October increase is negative, its effect on the maximum conforming limits will be deferred for one-year. Furthermore, the OFHEO said that the decrease would be netted against any increase next year for determination of the 2008 limits. If there were another drop next year, then the maximum loan limit would decline in 2008 by at least this year's percentage decline in average prices.

The OFHEO Director James Lockhart had said that the OFHEO wanted to ensure an orderly and transparent process if a downward adjustment in the limits was required. "We want to make sure that guidance exists to avoid disrupting the end-of-year pipeline of mortgages or the market for mortgage-backed securities." The GSE regulator expects to release formal guidelines for determining 2008 limits in early 2007.

Refi Index falls nearly 10%

In the holiday week ending Nov. 24, mortgage application activity fell 4% overall as a result of decline in refinancing activity. According to the Mortgage Bankers Association, the seasonally adjusted Refinance Index dropped 9.6% to 1749.6 despite a decline in the 30-year mortgage rate to 6.18% from 6.24% in that week. Meanwhile, the Purchase Index rose 1.3% to 406.7. A year ago, purchase activity was at 476. The MBA also reported a one basis point decline in the 30-year fixed contract rate to 6.13%.

Lehman Brothers economists noted that the mortgage application data is suggestive of a near-term bottom. In particular, they said that while the Refinance Index fell last week, it is up nearly 18% year-over-year. In addition, looking at the data using moving averages shows the 16th consecutive week of improvement. Purchases have also shown improvement for sixth straight weeks viewed through moving averages.

Regarding the MBA Refinance Index levels in 2007, JPMorgan Securities analysts expect it to be around 1900 to 2000 next year with no change in rates versus the 1700 to1800 area in 2006 - in large part due to ARM resets. About $400 billion in resets are seen in 2007. Just this alone should add nearly three CPR to aggregate speeds, analysts said. However, nearly offsetting is the decline in speeds related to the expected drop in cash-out refinancings. Freddie Mac is currently estimating cash-out volume to decline to $180 billion from $286 billion this year.

30-year fixed mortgage rates decline

Freddie Mac reported mortgage rates fell three to four basis points across various lending programs last week. In particular, both 30- and 15-year fixed mortgage rates slipped four basis points to 6.14% and 5.87%, respectively. The 30-year mortgage rates are at their lowest since late January of this year. They are also down 12 basis points from a year ago. For the month of November, 30-year mortgage rates averaged 6.24%, down from an average of 6.36% in October.

No doubt the Thanksgiving break deterred borrowers from application activity as well as recent seasonal adjustments used by the MBA for both Thanksgiving and the previous Veterans Day holidays caused distortions. Some recovery is expected this week in refinancings as the holiday focus is past and rates are down even more from the previous week.

Prepayment outlook

Speeds in November are expected to slow 3% to 5% on average with discounts showing larger percentage declines - around 6% - versus par and premiums - about 3%. Factors influencing the report include slowing seasonals and one less collection day. On average, the Refinance Index was up less than two percent in October versus September; 30-year mortgage rates averaged just four basis points lower. The November report will be out this Wednesday evening. JPMorgan analysts had previously estimated paydowns to total around $38 billion.

Looking out to December and January, speeds are anticipated to slow about 6% each month.